Fair Market Value - What is FMV and How to Calculate It

Ever tried to bargain over what you want to buy? Quoting a high price, slightly coming down, gauging how much you can reduce the price, comparing it with the market price, then finally landing at a slightly lower price than offered in the market.

Unknowingly, you have negotiated a deal, with a fair-market assessment, analyzed its dynamics, and leveraged it to your advantage. 

Fair Market Value, as its name suggests, is determined fairly by the consensus of both buyers and sellers in the market. Learn more about its meaning, calculation procedure, valuation methods and examples.

What is Fair Market Value?

Fair Value or refers to the price set for selling or purchasing an asset in the open market. Financial institutions like NBFCs and Government organizations use Fair Value while assessing the valuation of collateralized or taxed assets.

Several conditions need to be fulfilled to determine an asset's Fair Value. Buyers and sellers must have full knowledge of an asset before participating in a transaction. Their decision should not be influenced by time or any other external factors. Insurance claims, charity, property taxes, stock ownership, etc., are some transactions requiring this value.

How to Calculate the Fair Market Value?

The calculation of FMV primarily depends on the type of assets. You need to consider some factors while assessing an asset’s Fair Market Value. The uniqueness of an asset, its depreciation status, sales, liquidity, etc., are some factors to look for.

Thus, FMV depends on an appraiser’s subjective decision after assessing a specific asset class. You can also determine this value by considering the asset’s cost to its seller. You can assess it through the details of similar objects that have been sold.

You can estimate as opposed to compute fair market value in a couple of different manners. First, by the cost the item paid the seller, through a list of sales for objects comparable to the asset being sold, or an expert opinion. For instance, a diamond appraiser would probably be able to recognize and compute a diamond ring based on their expertise.

Underlying  Assumption while calculating Fair Market Value:

• The asset is reasonably known to both the buyer and the seller.
• Here both seller and buyer will have their own interest.
• There is no excessive pressure on either party. Each is given a reasonable period for completing the transaction.

Fair Market Value Calculating Method:

You can use these five methods for Fair Market Value valuation:

• Selling price

You can evaluate the Fair Market Value of an asset based on information about its recent purchase or sales price.

• Replacement charges

This method helps you determine the value of purchasing or building an asset or property using a similar asset. It helps you prepare a tax return or file an insurance claim.

• Cost of comparable assets

Real estate agents often provide you with a list of sale prices for neighbouring homes or properties when you intend to sell a property. This is known as a comparable value. You can determine an asset’s FMV using comparable costs. This is also known as Market Approach.

• Professional opinion

You can hire an expert appraiser to know a property’s valuation. The expert will provide you with your property’s FMV.

• Income Approach: 

The income approach assesses the FMV based on the future cash flows the asset is expected to generate. This method involves discounting these future cash flows to their present value using an appropriate discount rate.   

Fair Market Value Example

Let’s assume you will sell your house. If you find a buyer willing to purchase it at your decided price or a higher price, you get a Fair Market Value for the house. It goes the same when you are planning to sell a used car. FMV is determined as per the highest bid you receive from a buyer.

As per the Indian Accounting Standard, the Fair Market Value of a property refers to the price a seller earns by selling it. However, the market value of a property depends on certain conditions. First, buyers and sellers must be aware of the property on sale and proceed in their own interest and not under pressure. Secondly, the transaction needs to be completed within a given time.

While assessing and taxing a property, the government must also determine its FMV. The difference between FMV and a property’s purchase price depends on its holding period. Generally, FMV is higher than the assessed value of a property. However, you can file a dispute if it exceeds your expected Fair Market Value.

Significance Of Fair Market Value:

• Legal situations: In the event of a divorce settlement or payment of damages due to harm caused to private property, the fair market value of the asset in question is used.
• Taxation: Fair market value is applied in determining the municipal property taxes payable by an owner. Tax deduction is also possible on casualty loss and asset depreciation. For charitable contributions, the fair market value of the contribution is utilized for tax purposes. Thus, a taxpayer can get a tax credit for the fair market value of the contribution given.
• Insurance: Fair market value is also decided in insurance claims. When an insured vehicle is damaged, the insurance claim is relative to the fair market value of the vehicle at the present moment and not what the vehicle was purchased for.

Practical Uses of Fair Market Value:

Local property taxes tend to be based on the FMV of the property owned by the taxpayer. The contrast between the cost of the home and the FMV of the residence can be extreme depending upon how long the owner has owned the house. Professional appraisers follow guidelines, standards, and national and local rules to set the FMV for a home. FMV is also commonly utilized in the insurance sector. For instance, when a car accident results in an insurance claim, the insurer of the damage to the owner's vehicle normally pays for damages up to the value of the vehicle's FMV. 

Fair Market Value of Shares

It is assumed that marketing price data often contains errors. Thus, to assess the normal share price, you need to consider the average trading price of a particular day. Thus, the Fair Market Value of a share is determined by the latest trading price of a publicly-traded company.

Example, If a stock's highest price is $100 and lowest price is $95 on a given day what will be the FMV? 

FMV = (Highest Selling Price + Lowest Selling Price) / 2

                  = ($100 + $95) / 2 

         FMV   = 97.50$

Fair Market Value in Income Tax

As per Section 2(22B) of the Income Tax Act, the price of capital gains sold on a relevant period in the open market is FMV. If FMV cannot be assessed hypothetically, it is determined using this rule.

Fair Market Value and Taxation: 

Fair Market Value (FMV) is a crucial concept in taxation, especially under the Income Tax Act, and is used to determine the value of an asset for the purpose of calculating capital gains, perquisites, and gifts, among others.

Instances where in transaction made not in line with FMV treated in Income Tax laws

• If an individual or HUF receives immovable property or certain movable properties for less than FMV, the difference is taxed as "Income from Other Sources".
• For Employee Stock Option Plans (ESOPs), the FMV on date of exercise is used to compute taxable perquisite value.

Challenges in determining the Fair Market Value:

Fair Market Value (FMV) is challenging because there are a number of challenges that affect reliability and accuracy. The most major challenge is access to comparable data. For specific or unusual assets, it might be challenging to find current, appropriate sales to derive benchmarks. In the same way, the fast-changing nature of market conditions like economic cycles or unexpected changes in an industry can skew FMV estimates and render trends more difficult to foresee.

Subjectivity comes into play as well because various valuators will interpret the same information in different manners, resulting in differing FMV estimates. Intangible value assets such as intellectual property or goodwill also present special valuation issues since the intangible assets do not have concrete reference points.

Regulatory and legal conditions also complicate FMV determinations, especially for use in tax or litigation situations where accuracy is absolutely essential. Defeating these challenges demands experience, sound analysis, and deliberation about market subtleties to reach a valid and defendable valuation.

Fair Market Value vs Market Value

In Fair Market Value, both buyers and sellers could agree upon a certain price without any influence of external pressure. It generally refers to an asset's current value. Both the sellers and buyers need to agree upon a certain price in the open market to declare the FMV of a particular asset.

However, the demand and supply of a certain product determine its market value. It has little influence on an asset’s current value. Transactions in the stock market usually take place on the market value of the security.

Now that you know what is a Fair Market Value and how to assess it, you can determine the FMV of your property, car, and other assets feasibly. However, it is advisable to opt for an expert suggestion while assessing FMV to avoid miscalculations. Professionals remain updated with the recent market trends, so they can help you with accurate figures.

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